Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies China Zhonghua Geotechnical Engineering Group Co., Ltd. (SZSE:002542) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is China Zhonghua Geotechnical Engineering Group's Debt?

As you can see below, at the end of December 2023, China Zhonghua Geotechnical Engineering Group had CN¥3.15b of debt, up from CN¥2.82b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥884.3m, its net debt is less, at about CN¥2.27b.

How Strong Is China Zhonghua Geotechnical Engineering Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Zhonghua Geotechnical Engineering Group had liabilities of CN¥4.25b due within 12 months and liabilities of CN¥1.83b due beyond that. Offsetting these obligations, it had cash of CN¥884.3m as well as receivables valued at CN¥5.05b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥159.5m.

Of course, China Zhonghua Geotechnical Engineering Group has a market capitalization of CN¥3.76b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Zhonghua Geotechnical Engineering Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, China Zhonghua Geotechnical Engineering Group reported revenue of CN¥2.5b, which is a gain of 16%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months China Zhonghua Geotechnical Engineering Group produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CN¥724m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥739m into a profit. So to be blunt we do think it is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for China Zhonghua Geotechnical Engineering Group that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.